Researchers Link Questionable Mergers to CEO Arrogance

Research by two University of Iowa business professors reinforces the adage that CEOs should not believe their own hype.

The work provides the first evidence suggesting that CEOs fall victim to their own perceived success when making merger and acquisition decisions. The research suggests that CEOs unwittingly give too much credit to their own ability when they initiate a successful acquisition, and that overconfidence then encourages them to make more acquisitions later that are more apt to lose shareholder value.

But Matt Billett and Yiming Qian, finance professors in the Tippie College of Business, said their work also demonstrates CEOs likely have no sinister motives behind their value-destroying acquisitions, and that they frequently believe they are acting in the best interests of their shareholders.

Billett's and Qian's research is contained in their paper, "Are Overconfident CEOs Born or Made? Evidence of Self-Attribution Bias from Frequent Acquirers." Their finding is that such CEOs are, in fact, made.

The two researchers examined mergers and acquisitions of publicly traded companies between 1980 and 2002, estimating the value of each by the stock market's reaction upon its announcement. They found that while a CEO's first acquisition leads to essentially no change in company value, subsequent mergers show a mean drop in value of 1.5 percent.

So what does determine the success of a merger? Billett and Qian suggest that simple chance is as likely a cause as anything.

"The research showed that post-acquisition stock returns are mixed, with some performing better and some worse," they said. "This suggests post-acquisition performance is probably due to chance."

In other words, they said, it's a coin flip. What happens, however, is that some CEOs who successfully call the coin flip begin to think their skill had something to do with it and that belief colors their later moves.

"A CEO who is subject to self-attribution will tend to mistakenly credit ex-post success to her own ability," Billett and Qian write. "'Success' from prior acquisitions therefore leads to overconfidence and leads the CEO to more acquisitions. These subsequent acquisitions, however, will exhibit overconfidence and will be value destructive."

Insider trading data also demonstrates this hubris at work, as Billett and Qian found CEOs frequently purchase more of their own company's stock during the run-up to an acquisition. The researchers suggest this demonstrates the CEOs believe their acquisitions will be successful, because executives who know in advance their acquisitions aren't likely to build value are also not likely to buy more shares of their own stock.

The researchers suggest in their paper that firms can counteract this hubris effect by more thoroughly examining acquisition proposals from CEOs who have been involved in multiple acquisitions in the past.

Billett's and Qian's paper will be published in a forthcoming issue of the journal Management Science.